Tax Evasion or Tax Avoidance: What You Should Know about Donald Trump's Taxes

Revelations that U.S. Republican presidential candidate Donald Trump has paid no federal taxes for the past 18 years has set off a storm of controversy. Trump allegedly used a $916 million loss in 1995 to avoid paying taxes for close to two decades, deducting it as a net operating loss. It remains clear how, precisely, Trump lost this inordinate sum of money, but it was likely through some combination of money lost on his casinos, his Plaza hotel property in Manhattan, and his airline, along with personal financial liabilities.

Trump openly admitted to taking advantage of U.S. tax loopholes at the second presidential debate. “I absolutely used it, and so did Warren Buffett, and so did George Soros, and so did many people who Hillary is getting money from,” he said, adding that he knew more about the U.S. tax system than anyone else.

He reiterated the sentiment at a campaign event in Colorado earlier this month. “I was able to use the tax laws in this country and my business acumen to dig out of the real estate mess,” he said. “Few others were able to do what I did.”

While the ethical elements of Trump’s tax strategy are certainly debatable, what remains clear is this: The presidential candidate’s tax avoidance scheme was perfectly legal. U.S. tax law mandates that a business — no matter how big or small — can avoid paying taxes if it incurred some kind of economic loss in the previous year. The logic behind the law is simple. The idea is that exempting businesses that are running in the red from paying taxes to the government can help them weather economic downturns and, hopefully, thrive again when the economy picks up.

This rule in U.S. tax law dates back to 1918, and it is routinely taken advantage of by taxpayers. Some 500,000 people claimed the same deduction as Trump in 1995, though the average loss they claimed was around $97,600. The amount Trump claimed as a net operating loss is certainly extreme. The New York Times reported that that staggering figured amounted to close to 2 percent of the net operating losses claimed by all U.S. taxpayers in 1995.

It also isn’t unusual that Trump’s business losses showed up on his personal tax returns. In the U.S., businesses are most commonly structured as “pass-throughs,” rather than corporations. That means that profits are passed through to the business owners and subsequently taxed as personal income. The same applies to losses.

The bottom line is that no matter what you think about Donald Trump or his tax strategy, the $916 million dollar write-off was completely legal. However, whether this strategy makes Trump a good businessman — like he claims — is questionable.

“He was forced to sell many of his investments in the early 1990s, at pennies on the dollar, teetering on bankruptcy,” Edward Kleinbard, a tax expert at the University of Southern California, told the New York Times. “There were real economic losses from those investments — borne entirely by the lenders. Yet nonetheless he was able to emerge with a large net operating loss to carry forward, attributable primarily to losing other people’s money.”